Time to rewrite the rules

business. The impact studies and the CESR opinions have rarely taken into account the consequences for depositaries and, more broadly, for back offices. Whether it is the creation of the category of sophisticated Ucits or making more assets eligible for Ucits, changes to European law often assume that ‘stewardship’ will follow. The Madoff fraud suggests that it might well be worth ensuring that stewardship really does follow. So we think that a specific study of the world of alternative management would reveal the limitations of current regulation, of the restitution obligation, for example. Such a study would make it possible to examine the suitability of the regulation for modern financial instruments and asset management techniques. In addition, a broader study of the entirety of the fund management industry is needed. It seems to us that the study should include a number of elements. A description of the functions and role of main parties involved in the management of investment funds in certain key countries of the European Union is needed. The legal rules and the consequences of the legislation on the definition, limits, and obligations linked to the businesses of service providers in the fund management value chain has to be considered. Also there needs to be an assessment of the risks to which the major parties are exposed, with an approach based on the analysis of responsibilities, as well as with an analysis of the major historical cases of large losses in the international asset management industry. In the wake of this study, it will be possible to make proposals for improved liability rules. These proposals should naturally be made available for industry evaluation, with a call for reaction to the proposals, as the European Commission is doing with the AIFM directive, and a more detailed study making it possible to evaluate the practices of depositaries as well as possible changes to the profession as perceived by wealth management firms (the tension between a need for greater protection and the implications in terms of pricing) and, if possible, by end-investors. f e

degree of protection offered investors by service providers.

market for investor protection by depositaries should also involve optional component guarantees (beyond a minimum base that may include the inversion of the burden of proof for conventional products). Risk quantification and transparency A great diversity of levels of protection offered by depositaries both to asset management firms and end-investors will survive even after the establishment of a minimum requirement. Beyond the minimum that the European Commission should require, there may be divergences from one country to another in the transposition into national law as well as in the organisation of domestic markets; in addition to regulatory arrangements, depositaries may offer contractual services associated with transfers of liability. So it is essential for asset management firms and investors to be informed of the degree of risk they must bear, all the more so as knowledge of operational risk is not sufficiently widespread among either asset management firms or end-investors, including the so-called qualified investors, characterised by their knowledge of financial instruments and risks but not necessarily of the non-financial risks in the management chain. It is clearly more important to quantify the degrees of risk offered investors and to regulate communication on these risks than to spell out the minimum requirements depositaries must meet. Information on non- financial risk is indeed inadequate, and it does not make it possible for an investor to assess the non-financial risks he takes and to rank funds by the degrees of protection offered, because these risks are not quantified. We support the intention of the AIFM directive proposal to make sure that investors are informed of the identity of the depositary and of its obligations in the event of losses, as well as of the identity of any sub-depositaries, but this information is not of a quantitative nature and does not make rankings possible. This issue of the quantification of risk is relevant to the measurement, control, and reporting of financial risk as well, as emphasised by the Committee of European Securities Regulators (CESR). In this context, the establishment of a common minimum requirement spelled out by a European depositary directive cannot, given the divergences that will remain in domestic regulation, in practice, and in contractual terms, take the place of the use of tools that make it possible to qualify and to quantify the

Study of risks and regulations In its consultation, the Commission points out that protecting investors from non-financial risks is made difficult by the changes in products and techniques: “Since 1985, the European asset management industry has changed. Financial products now eligible for Ucits portfolios are more complex and are often registered outside the EU in third countries and emerging markets jurisdictions.” These circumstances may justify clarification of the responsibilities of depositaries and even a strengthening of oversight obligations, but these new tools require above all a study of the large non-financial risks and of the regulations of those in the management chain, a study that should take into account modern asset management instruments and techniques. The responsibilities of the depositary and the costs associated with the obligations that it must meet cannot be analysed without a parallel examination of the changes to the texts governing the parties and products involved in European investment fund We think that a specific study of the world of alternative management would reveal the limitations of current regulation, of the restitution obligation, for example

• Samuel Sender is applied research manager at Edhec-Risk

• This article was based on research carried out within the Edhec/Caceis Risk and Regulation in the European Fund Management Industry research chair

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